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organization.
Intermediate products are the products transferred between subunits of an organization. AB Company Ltd C Company Ltd
Firm with vertical integration, having different value-creating activities in the value chain
Division A TP = Variable cost + Lost contribution per unit per unit on outside sales
Division B
A common approach is to set the transfer price equal to the price in the external market Market price is best transfer price as it represents the opportunity cost from point of view of both the division are concerned. Market prices also serve to evaluate the economic viability and profitability of divisions individually.
Essentials
profit is the performance measure
Constraints
For differentiated products- no outside source exists.
freedom to outsource
When transfer prices are based on full cost plus a markup, suboptimal decisions can result. Cost based transfer price are used when there is no outside buyer available It involves two tasks: ---- Determine the cost of products -----To set up the profit mark up About half of the major companies in the world transfer items at cost.
Variable cost
Full cost
Dual Pricing
Dual Transfer Prices selling product at different prices in different markets the practice of setting different prices for the same product in the different markets in which it is sold The practice of setting prices at different levels depending on the currency used to make the purchase. Dual pricing may be used to accomplish a variety of goals, such as to gain entry into a foreign market by offering unusually low prices to buyers using the foreign currency, or as a method of price discrimination .
Variable cost: under this approach variable cost is set as the transfer price.
The problem with this approach is that the producing division is not allowed to show and contribution on the transferred goods, even if it has excess capacity
Under this method transfer price is equal to variable cost of Variable costs the product plus an allocated portion of the fixed overheads. Transfer price based on full cost run the risk of causing dysfunctional decision making behavior. This happens because the buying division perceives the fixed cost to the company as a whole as variable cost to the buying division
Negotiated transfer prices arise from the outcome of a bargaining process between selling and buying divisions Division managers actually negotiate the price at which the transfer will be made. Sometimes they start with market price and make adjustments for various reasons. This method is used sometimes when no external market exists for the product.
Two drawbacks of this method are -divisiveness and competition between division managers and undue weight age to negotiating skills of a manager in appraising his performance
Virtually any type of transfer pricing policy can lead to dysfunctional behavior actions taken in conflict with organizational goals.
1Goal Congruence
6 Multinational companies use transfer pricing to minimize their worldwide taxes, duties, and tariffs
Culture Prevailed
Organization Structure
Extend of negotiation
Capacity utilization
Comparison of Methods
Achieves Goal Congruence
Market Price:
Cost-Based:
Negotiated:
Comparison of Methods
Useful for Evaluating Subunit Performance
Market Price:
Cost-Based: Negotiated:
Yes
Comparison of Methods
Motivates Management Effort
Market Price:
Yes
Cost-Based:
Negotiated:
Yes
Comparison of Methods
Preserves Subunit Autonomy
Market Price:
Cost-Based:
Negotiated:
Comparison of Methods
Other Factors
Market Price:
Cost-Based:
Negotiated:
Strategic Factors
International Transfer Pricing Consideration
Tax Rate- minimize taxes locally as well internationally Exchange Rate Custom Charges Risk of expropriation Currency Restriction
Strategic relationship
Assist bayside division to grow Gain entrance in the new country Suppliers quality or name
MarketBased
Yes, when markets are competitive
CostBased
Often, but not always
Negotiated
Yes
Difficult unless transfer price exceeds full cost and even then is somewhat arbitrary
Yes, but transfer prices are affected by bargaining strengths of the buying and selling divisions
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MarketBased
Yes
CostBased
Yes, when based on budgeted costs; less incentive to control costs if transfers are based on actual costs
Negotiated
Yes
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MarketBased
CostBased
Negotiated
No market may Useful for Bargaining and exist or determining negotiations markets may full cost of take time and be imperfect or products; easy may need to be in distress to implement reviewed repeatedly as conditions change
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